This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, click the "Reprints" link at the bottom of any article.

May 11, 2012

Zvi Bodie: I Bonds Are Best for Most Investors

To worry-free investing proponent, recommending inflation-protected bonds is the first test of advisor competence

Zvi Bodie, safe-investing proponent and financial services industry gadfly, says Series I savings bonds are the best investment for most people, yet few know about these inflation-protected bonds that can be easily obtained with a few clicks of the mouse at the Treasury’s website. Bodie (left), a veteran professor at Boston University, on Thursday launched the website for his most recent consumer-oriented book, Risk Less and Prosper.

The book is critical of most though not all financial advisors, and in an interview with AdvisorOne, Bodie lamented that advisors are not telling their clients about Series I savings bonds, which currently pay 2.2%, or the rate of inflation on top of a base rate currently fixed at 0%. U.S. citizens can currently purchase up to $10,000 of I bonds per person per year.

AdvisorOne: What is the essential value proposition of Series I bonds?

Bodie: For most Americans the safest investment is Series I savings bonds. For the past several years the U.S. Treasury has been offering these bonds to the public at a guaranteed interest rate that is at least equal to the rate of inflation for a period of 30 years. This means that for every dollar you invest today, you have the right to take it out fully adjusted for inflation at any time over the next 30 years. So in a worst-case scenario (unless the U.S. government defaults), you will have maintained the purchasing power of your money.

AdvisorOne: Are there are other benefits to owning them?

Bodie: If the Treasury raises the interest rate above the rate of inflation, you can cash in your old bond and buy a new one with no loss of accumulated interest. If you have held the old bond for over 5 years, there is no penalty when you cash it in.

AdvisorOne: Can advisors' clients build a retirement off of these bonds?

Bodie: I know of no safer way to invest for a long time horizon. For people of modest income, a combination of Social Security and an annual investment of up to $10,000 per year in I Bonds should suffice to finance a comfortable retirement without any significant risk and without any special tax-deferred retirement accounts. For example, a 30-year-old who buys $10,000 per year of I Bonds and retires at age 70 will have accumulated $400,000 of today’s purchasing power. Even at today’s high prices that would be enough to buy a guaranteed lifetime inflation-proof income benefit of more than $16,000 per year from a high quality insurance company. I believe that this option ought to be brought to the attention of every American by the government and trustworthy financial advisors.

The new website for Risk Less and Prosper contains a video page consisting of nine simple explanations of what regular working Americans. These videos, plus a tenth that was omitted from the book site, were created in 2009 for employees enrolled in Boston University’s 403(b) plan. In a novel employee retirement benefit, Boston University’s Human Resources website offers employees retirement investing advice from two of its faculty notables, Bodie and Laurence Kotlikoff.

The university’s retirement planning resources and tools aim to help employees confused about investing while at the same time showcasing their in-house experts. Bodie’s videos are aimed at simplifying key concepts of retirement investing.

Video 1, called “The Conventional Wisdom is Wrong,” is an economist’s rebuttal to the conventional Wall Street idea that long-term investors should be in stocks. “The length of your time horizon has nothing to do with your willingness to take risks,” Bodie says. “Stocks are just as risky in the long run as in the short run. In some ways stocks are even riskier in the long run,” he adds. The finance professor explains that one’s time horizon instead determines the appropriate safe asset class—money-market instruments for a short term, and long-term bonds for a longer term.

Video 2, called “You’re on Your Own,” discusses the demise of defined benefit plans and the prevalence today of defined contribution plans like 401(k)s and 403(b)s, where employees themselves assume all investment risk.

“Essentially, you’re on your own today,” Bodie says. The professor criticizes the trend toward target-date lifecycle funds as default options, which he says give investors a false sense of security that when their retirement target date (say, 2040) comes up, they’ve achieved their goal. But target-date funds offer no guarantees whatsoever, he says, pointing out that those invested in 2010 target-date funds lost 30% or more of their portfolio just before their retirement.

Video 3, called “Set Realistic Goals,” counsels using TIPS as a starting point for building your portfolio with rates that guarantee inflation will not erode the value of the principal investment. Bodie cautions investors putting money into stocks that they must increase how much they save commensurate with the risk of losing on those investments (while superior investment results early on may allow investors to save less in the future).

Video 4, called “The Safest Investment is TIPS,” goes a little deeper into Treasury inflation-protected securities, advising investors to start off by determining how much they would have to save if they want to take no risk at all.

As in Video 1, Bodie criticizes investment industry literature (and even the SEC’s website) for promoting the idea that investors should rely on stocks to hedge against the risk of inflation. That’s “going out of the inflation frying pan and jumping into the stock market fire,” he says.

Bodie says that as long as investors match the maturity of TIPS to their own planning horizon, TIPS are the safest investment. He is critical of TIPS funds for blending maturities. “That introduces risk,” he says, because investors don’t know what the value of the shares will be at the time of their retirement.

Video 5, called “BU Will Be the First to Offer It,” is omitted from his Risk Less site because it is no longer operable. In it, Bodie said that TIPS mutual funds are the best available option in Boston University’s plan, but said they are inferior to buying TIPS directly from the Treasury, which would allow investors to obtain a maturity that matches their individual investment horizon.

Bodie says the university’s human resources department is engaged in a pilot project, under his guidance, that should make the school the first institution granting its employees access to the government’s website, Treasury Direct, for TIPS purchases. He told AdvisorOne that industry influence over the Treasury blocked his ambition to grant employees that direct access to Treasury Direct through their 403(b) plan.

Video 6, called “I Love the Stock Market,” again criticizes investment industry literature and takes the SEC to task as well for promoting the idea that a long time horizon reduces stock market risk.

Bodie acknowledges that stocks have beaten inflation by a significantly greater degree than TIPS’ safe rate. But he counsels investors to appreciate the fact that stocks’ average rate of return may not be their own rate of return. “There’s a wide distribution of values you can end up with,” and the worst outcome is much worse than TIPS. He compares the risk of long-term stock market losses to the risk of a fire burning one’s home. Even if the probability of loss is small, he says, homeowners still are willing to spend $1,000 or more a year to insure against it because the possibility of loss would be catastrophic.

Video 7, called “Don’t Trust Anyone,” warns of well-intentioned uncles or neighbors who might have your best interests at heart but may not know what they’re talking about. Bodie also plugs NAPFA as one of the only organized advisor groups that swears an oath of fiduciary responsibility to put their clients’ interests first. (The CFA Institute's Chartered Financial Analysts are another such group, Bodie told AdvisorOne.)

But Bodie does not endorse every advisor on NAPFA’s rolls. Rather, he recommends those seeking professional help to ask a prospective advisor, as a test question, what they think of Series I savings bonds. “If you don’t get, ‘That’s a pretty good idea for money that you want to stay safe,’ then I would look elsewhere for an advisor,” Bodie says.

Video 8, called “Stay in the Labor Force,” counsels maintaining a job-based income until at least age 70, which is the latest year that deferral of Social Security will result in a benefits increase worth about 8% per year. Those not yet retired should work at least part time, he says, and those already retired should consider finding a job they like for added income.

Video 9, called “I Hate Losing,” warns against hot tips, which should be regarded more as urban legend than solid advice, Bodie cautions.

Video 10, called “Three Crucial Tips,” offers important takeaways that should guide retirement savers. First, they should think about saving and investing for retirement the same way they think about insurance—that it is about protecting their standard of living, not about speculating. That is the secret to what Bodie calls “worry-free” investing.

Second, investors should be wary of investment industry people and products. Rather than put their faith in people, they should rely instead on guarantees. Target-date funds, he says, don’t come with guarantees, but they do come with assurances that investors are bearing all the risk. He says these asset managers understand risk management better than their customers, so he asks, rhetorically, why is it OK for investors to assume the risk but not the asset managers. In other words, investors should guarantee the income that is important for their retirement.

Bodie’s final point is that investors should educate themselves about their finances. By analogy, Bodie says that he would not be his own doctor, but enjoys reading about health care in books written for non-professionals. That enables him to enjoy making choices presented to him by the experts.

The Boston University site also makes available the financial planning software, ESPlanner, created by the BU economist Laurence Kotlikoff (left), a current third-party presidential candidate.The basic version of the software is made available to BU employees as a fringe benefit and aims to help them smooth out consumption of their income before and after retirement (there is also a souped-up advisor version called ESPlannerPro).

The tool allows consumers to alter assumptions about the length of employment and saving to show how they might increase their living standard while maintaining an investment floor for safety.

Contrary to most industry-based approaches but consistent with economic theory, the program assumes that the more capital invested in stocks, the less income is available as a floor (because of the risk of impairment of capital) but the higher the upside. Conversely, the less invested, the higher the current income available but the lower the upside.